CREDIT MARKETS

CREDIT MARKETS; Bonds Plunge, but End Higher

By H. J. MAIDENBERG

Published: April 28, 1987

The bond market staged a dramatic comeback yesterday after another plunge in prices earlier in the session.

Because the rally was sparked by what the Federal Reserve was expected to do but did not do, relatively few institutional investors entered the market. As a result, dealers said they were forced to mark down prices late in the session.

Still, prices of the longer Treasury maturities, which bore the brunt of last week's selloff, posted moderate to large gains on the day.

For example, the bellwether Treasury long bond, the 7 1/2's of 2016, were offered late in the day at 88 1/32, up 20/32, for a yield of 8.62 percent. Before the rally, the long bond had been down as much as 54/32, and the yield was well above 8.80 percent.

What the Fed had been expected to do was to inject reserves into the banking system for three or four days through repurchase agreements. This would have driven down the key Federal funds rate, or basic overnight lending rate, on which other rates are based. Yesterday's inaction by the Fed contributed to a further rise of 5/8 of a point, to 6 7/8 percent. Normally, a decline in the Fed funds rate would have caused other interest rates to fall and raise prices of existing fixed-income securities. Dollar a Major Concern

But these are not normal times in the bond market. Rather than fear a rise in interest rates, many investors would welcome a moderate upturn as an indication that the Fed was moving to strengthen the dollar to attract foreigners to the bond market.

When the Fed again took no action to lower the Federal funds rate, more market participants, at least the dealers, were convinced that the central bank was continuing its recent practice of allowing rates to further ''snug,'' or gradually rise, and thus enhance the dollar's value.

Moreover, the Fed's inaction at its usual pre-noon-hour intervention time came moments after Administration officials again said that a further decline in the dollar would be counterproductive. Even earlier, several central banks had moved to support the dollar.

As long-term interest rates plunged and the dollar appeared to stabilize, precious metals prices began to plunge, which further encouraged the bond market. Prices were also bolstered by large short covering by dealers and investors who sought to protect their inventories and portfolios from further price drops by selling bonds short last week. 'Like the Stock Market'

''But the turnabout was too sudden to attract significant numbers of investors, many of whom have been mauled in recent weeks by the bond market's uncommon volatility,'' said Robert W. LeLacheur, vice president-bond market research at Salomon Brothers. ''Why, the bond market is now behaving like the stock market, what with prices soaring one day and plunging the next.''

Because yesterday's rebound in bond prices after last week's heavy selloff was based more on a change in market perception rather than fundamentals such as investor demand, Mr. LeLacheur said that institutional and other bond investors were fearful of being whipsawed by the increasingly volatile nature of the market.

''In a word, the bond market is now very tense, with investors wary of any one-day rally,'' Mr. LeLacheur added.

Strong Treasury bond futures prices further strengthened the cash market. The spot June bond contract closed up 1 20/32, at 91 6/32. When the Chicago futures market closed at 3 P.M., New York time, the cash market began to weaken.

Norman E. Mains, financial futures specialist at Drexel Burnham Lambert in Chicago, said: ''The now widespread belief that the Fed is continuing to snug short-term rates, perhaps in preparation for a small rise in its discount rate, set off buy orders in the futures as rapidly as they triggered stop-loss orders last week. Consequently, today's price rise may have been as exaggerated as last week's price drops.'' 'Ted Spread' Narrows

Because short-term rates influence those on longer maturities, the narrowing of the price difference between the spot June 90-day Treasury bill and Eurodollar futures, known as the ''Ted spread,'' is a key indicator of general trends in interest rates. A narrowing of the spread is a sign of lower interest rates and a widening is considered bearish for the fixed-income securities market.

Mr. Mains noted that the Ted spread narrowed yesterday to 68 basis points from 125 last Friday, an extraordinary sharp move that was attributed in large part to the resignation over the weekend of Brazil's Finance Minister, Dilson Funaro, who had imposed a moratorium on interest payments to foreign banks last Feb. 20.

The moratorium caused many investors in the certificates of deposit of banks involved in Brazil to switch to Treasury bills.

At the Treasury weekly auction of bills, the average discount rate on the 90-day issue rose slightly, to 5.79 percent, from 5.77 percent the week before, while that on the six-month bills advanced to 6.14 percent from 6 percent.